Microsoft Earnings Preview: Device Sales And Business Strategy In Focus

Microsoft is set to announce its Q2 FY 2014 earnings Thursday, January 23. While the search for a new CEO to lead the company is still underway, the focus in this earnings announcement will be on declining global PC sales and Microsoft’s strategy to bolster its revenues through the sale of smart connecedt devices such as tablets and smartphones. Furthermore, as the company continues to focus on products and services such as Hyper-V and Azure to counter the declining PC market, most of its revenue growth is expected to come from cloud initiatives. In this earnings announcement, we are also on the lookout for a number of key announcements including the strategy to integrate Nokia’s phone division into its existing portfolio of hardware devices.

The global PC shipment is still reeling from decline in demand. According to Gartner, the global PC shipments market shrank by 7% in Q4 2013. Microsoft is increasingly pursuing its devices and services strategy to reduce its reliance on PCs, and expand its footprint into the hardware and cloud services domains. The company launched Surface 2 tablets at the end of the third quarter, and its flagship Xbox-One gaming device in Q4. We expect the company to disclose the unit sales and revenue numbers for these device launches. This would give us a fair indication of how these devices have fared, and whether the company has made any headway in the tablets market.

Office Cloud Adoption To Gain Traction

Microsoft’s biggest revenue driver is its Office productivity suite and makes up almost 40% of its stock value according to our estimates. During Q1 FY14, Microsoft’s revenues from this division grew by 5% to $6 billion, mainly due to increasing adoption of Office 365 that clocked in over 2 million subscribers at a $1.5 billion annual revenue run rate. The company announced a number of steps such as free Office 365 access to students to ensure that it continues to dominate the industry. We believe that these steps will augur well for the company and help it in maintaining its market share in the future. Currently, we estimate that the company has close to 93% share in productivity software market. In the upcoming earnings announcement, we expect Microsoft to report increase in revenue run rate for Office 365 as its clients adopt the feature-rich, cloud-based Office software.

Focus On Cloud Services To Bolster Server Division

Microsoft’s Windows server division is the second largest business unit making up over 20% of its total value. This division has been the fastest growing division and witnessed 11% growth in Q1 FY14, driven by higher SQL server sales and adoption of cloud based Azure platform. We believe that the Azure platform will be a key growth driver for Microsoft going forward as companies around the world are looking to lower costs by adopting cloud based services. Additionally, many Microsoft customers depend on SQL servers for mission critical and business intelligence needs, specifically in the big data analytics domain.

Earlier, Microsoft announced the new server and cloud enrollment offers to boost subscription of its enterprise cloud offerings. We expect that this 15% discount on the core infrastructure suite data center licensing and service agreement (L&SA) will boost revenues for Microsoft in Q2 FY14. This will also help the company to outpace the growth of the server market, which declined by 3.7% in Q3. Therefore, we expect the server division to report good growth in revenues in this quarter as well.

PC Sales To Affect Windows OS Sales

Windows Operating System is Microsoft’s third largest division and makes up around 13% of its stock value by our estimates. This division continues to report decline in revenues due to decline in global PC shipments. According to Gartner, global PC shipments continue to decline and the market shrank by 7% in Q4 2013. We believe that decline in PC shipment will continue to affect Windows OS revenues in this quarter as well, and the company to report decline in sales.

Bing Revenues In Focus

The Online Services Division has negatively impacted Microsoft’s overall profitability as it continues to post operating losses. However, due to rise in Bing’s penetration, the division’s revenues have increased by 15% year over year in the first nine months of 2013, boosted by 47% growth in online ad revenues. Furthermore, its market share in the search market industry has increased by 1.7 percentage points in 2013 to 18.2%. As a result, the online advertising revenue grew 13% due to a 47% increase in search revenues in Q1 FY14. We expect this trend to continue in Q2 and the company to report growth in revenues and profitability from Bing in this earnings announcement.

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